From China to US: Beware of our $ bomb!

Days ahead of the upcoming Chinese New Year — which marks the Year of the Tiger in the Chinese zodiac — China’s military leaders have sounded a roar of warning to the US, by raising the prospect of an ‘economic war’ by dumping China’s holdings of US treasury bonds.

Such an eventuality, which some commentators have called the monetary equivalent of ‘dropping the nuclear bomb’, would almost certainly trigger economic turmoil — and trigger a collapse of the US dollar.

But economists told DNA that the generals’ ‘threat’ would be virtually impossible to deliver without harming China, and was only political bombast without an understanding of its economic repercussions.

In any case, the Army has no influence on how China’s foreign exchange reserve holdings are deployed, they added. The tough talk from three military officers — Major Generals Zhu Chenghu and Luo Yuan, and Colonel Ke Chungqio — came in the context of China’s angry responses to a recent US decision to sell arms to Taiwan, the de facto independent island over which China claims territorial sovereignty.

Luo, a researcher at the Academy of Military Sciences, was quoted as telling the official Outlook Weekly that China should retaliate against the US — but not just militarily.

“We should go in for a strategic mix of retaliation across politics, military matters, diplomacy and economics… For example, we could sanction them using economic means, such as by dumping some US government bonds.”

Apart from the Taiwan arms sale, Sino-US relations have come under strain from a variety of other issues: the upcoming meeting between President Barack Obama and Tibetan leader Dalai Lama, China’s reluctance to abide by an international consensus on sanctions to halt Iran’s nuclear program, and its undervaluation of its currency, the renminbi, which is aggravating global economic imbalances.

Yet, for all the underlying tensions, economists say that the threat to dump US bonds is virtually impossible for China to carry out.   
Patrick Chovanec, associate professor at Tsinghua University in Beijing, told DNA that the ‘threat’ reflected a “widespread misconception — in China and in the US — that China’s ownership of US yreasuries is a weapon it can use at its discretion against the US.”

It would, be added, “be a very self-destructive move for any number of reasons.”  At the first level, if China did dump some of its $2 trillion in dollar-denominated holdings, “it would have a potentially catastrophic effect on the treasuries that China still held.” But the Chinese dilemma goes deeper than that.

“The Chinese economy continues to depend on exporting products for dollars - and accumulating even more dollars,” noted Chovanac. Chinese exports, GDP growth employment — all of it depended on China’s continued ability to sell product for dollars.

“If China doesn’t believe the dollar is worth much, it has an easy choice: allow the renminbi to appreciate… But it doesn’t want to do that!”

Additionally, if China dumped US treasuries and switched to another currency - say, the euro — it would only transfer (and accentuate) its trade surpluses to another currency, and lead to similar trade frictions.

“Holding a stick of dynamite and saying ‘I’m going to blow us all up’… is not really a weapon, although that perception is very widespread among people who don’t appreciate the dimensions of the dilemma,” said Chovanac. The military officers’ threat was just as ineffectual as, say, a US Congressman — who had no influence on policy — sounding off on China, he added.

According to Arvind Subramanian, senior fellow at the Peterson Institute for International Economics, China’s exchange rate policy, apart from accentuating global imbalances, was victimising other emerging economies and developing countries that compete with China on trade.

In his estimation, a lot of other countries — not just the US and EU — were affected by China’s “mercanitilist” policies, and an appropriate response would require a broad coalition of emerging markets and developing economies apart from the US and EU.

The need, he argues, is for the US to fashion such a coalition, instead of taking on China by itself — by naming it a ‘currency manipulator’, for instance. Direction action of that sort “is not something that a proud and prickly nation like China will respond to.”